Wall Street guys are always going to be able to outrun the regulators, but the regulators are still going to have the last word. A former senior Wall Street M&A investment banker for seventeen years, William D. Cohan shares his wisdom on the relationship between Wall Street and the entrepreneur. The New York Times bestselling author of three non-fiction narratives about Wall Street, he reveals the risks in investing in initial public offerings and the lessons learned from the financial crisis of 2008. Learn from William’s insights on the regulation of the capital markets today and bond markets as the probable solution for the economic turmoil.

William, welcome to the show. My first question is given your experience with Wall Street, what is the relationship between Wall Street and the entrepreneur?

Some of these tech companies, these so-called unicorns, a lot more tech companies are able to obtain capital that they need in other ways besides going public from hedge funds, venture capital firms, private equity firms and funds from all sorts of sovereign wealth funds. There are all sorts of new and different ways. There are also other exchanges and other private capital marketplaces that have started to provide companies with capital that they need, in ways that are new and different than their existing core delaying the inevitable IPO. You’ll see Uber, even though it didn’t achieve the lofty goals that underwriters and the company may have hoped by being valued at something like $100 billion. It still was valued at $74 billion, which for an IPO and raising more than $8 billion in an IPO is still one of the largest of all times. The consequence of companies getting capital elsewhere and being able to delay what used to be the only way a company could get the capital it needed is that these IPOs are bigger and more of an event that they used to be in the past. Which unfortunately can allow for the process to be manipulated and retail investors taking it on the chin often happens. The dynamics on Wall Street in raising capital have been changing for some time. With the internet, I’m sure they’ll change even more.

With Uber specifically and I can’t speak to the more recent ones, but I know that there were a number of articles written after the IPO where Uber was losing money. They weren’t profitable and they required more and more rounds of funding. The IPO became a necessity in essence because I know that there were some end investors, there are some articles written about end investors not necessarily getting their investment back yet. With that as something I see in smaller companies that are raising capital, it’s more for not necessarily to be profitable right away but down the road. Is that an occurrence that’s happened in the past or is that more of a recent phenomenon?

It often becomes about the story and the industry that you’re in. You may be too young to recall one in 1999, 1998 but a lot of companies were trying to go public that had no business being public and were far from profitable. They were able to do it because investors couldn’t get enough of that company at the time after the collapse of the tech market and the tech bubble in March of 2000 combined with 9/11. A year and a half later, the capital market dried up for that risk. It’s like Rasputin, it came back from the dead. It keeps coming back and investors are willing to suspend their disbelief.

You’ll have an example of Amazon where it had years and years of losses and investors kept having faith and bidding up the price of the stock. Now, it is profitable and increasingly profitable. They’ve got other business lines like the Cloud business that they have, AWS that drives a lot of their profitability. Sometimes investors get rewarded for this blind faith. Other times, they get their head handed to them. By and large, the tech companies that are coming public now are older and are closer to profitability, and are bigger and more substantial than what was going on many years ago. That doesn’t mean that there aren’t risks for investors. Investing in IPOs is a risky thing to do. The Wall Street underwriters make it seem tempting and delicious, “You have to buy Lyft, you have to buy Uber.” That’s their job. They’re expert salesmen. It’s an investors’ job to be the caveat emptor, to be wary of what these guys are selling because ultimately, they’re benefiting themselves and their institutional investors and the early investors and not the people who are buying the IPO.

I know you’ve talked quite a bit in your books and also interviews you’ve done regarding how Wall Street is set up and one of the primary reasons why 2008 happened. Do you see the regulation of the capital markets changing as it relates to how they’re raising capital, the leverage that they’re using and the risks that they’re taking?

After the financial crisis in 2008, there’s obviously the regulatory environment tightened up considerably. We went from relatively Laissez-faire regulation to Dodd-Frank Laws, Volcker Rule and also some new regulations that were implemented. Basically, that all ended with the election of Donald Trump and now it’s pretty much being rolled back. It’s not exactly clear how it’s being rolled back but there’s the sense that there’s much less regulation now and deregulation is the way it’s going to be for the time being. Companies are taking advantage of that as best they can. On Wall Street, the Fed is the new regulator of all these Wall Street banks, the big ones, and the Federal Reserve. They’re not allowing any mergers. None of these big firms can do transformative mergers.

They haven’t been able to do that for more than ten years now. This is probably some pent-up strategic demand among these Wall Street firms for how they’re to potentially compete going forward. Until the fed allows them to do these mergers, they are not going to be able to. Other regulations are being loosened. Some capital requirements, the kinds of business lines they can be in, all of that is being loosened up to some degree. If you ask people on Wall Street, they say, “That’s great. It’s about time.” The post-financial crisis regulations were too restrictive. You ask good politicians like Elizabeth Warren and Bernie Sanders, they want to know do more. They don’t want to loosen these restrictions and these regulations. There’s always a pendulum. It was too loose before the financial crisis. Now that has to be tightened up so that “never happens again.” Now you could argue that it’s too loose again, that it was too tight. Wall Street types are never happy with any regulation.

If you were speaking on behalf of the typical investor, would you say that the lessons that came from some of the turmoil in 2008, 2009, the dot-com crash or earlier, aren’t necessarily an issue? That we’ve learned those lessons and that the growth that deregulation often creates is sustainable and there aren’t any unintended consequences?

Financial Crisis: The dynamics on Wall Street in raising capital are changing and have been changing for some time. With the internet, they’ll change even more.

I don’t think either investors or bankers or executives at banking firms ever learned their lesson about the financial crisis. They’re all in the business of trying to make as much money as they possibly can all the time. Whatever the capital markets permit, the regulatory environment permits or the business environment permits, they will push it to the max to try to make as much money as they can. I’ve written extensively over the last years about how frankly I see the problem repeating itself. The problem that got us into the financial crisis in 2007 and 2008 is being repeated now several years later. You can write about it until you’re blue in the face. Frankly, investors are buying up securities that are too risky and not getting compensated enough for the risk they’re taking.

That’s unfortunate, the way it all starts all over again. That’s part of driven by the Federal Reserve’s policy of keeping interested rates very low for a long period of time which was probably a strategy that made sense when we were in the peak of the financial crisis. Now, all these years later, unfortunately, it drives investors to take risks they’re not getting properly compensated for. That’s exactly what happened last time around several years ago and here we are doing it again. Do people learn lessons? No, they don’t. Will the next one happen exactly the way the last one did? No, it won’t. Will there be another financial crisis? Absolutely, you can bank on. It’s probably sooner rather than later.

I’m hearing you say that this is more a regulatory issue than anything else because obviously if there are certain rules and you have incentives of the Wall Street bank. They want to receive compensation and be rewarded for their efforts. They’re following rules to the best of their abilities. The regulation side of things is where the lynchpin is or am I misinterpreting that?

That’s right. Essentially, Wall Street is a Darwinian war pit where the battles are played out every day. It’s a zero-sum game. There can only be one winner as we used to say. One of the firms I worked at, “It wasn’t enough for you to succeed. Others had to fail.” Bankers, traders and corporate execs, all of those, they’re going to do whatever they can to make as much money as they can that is legal. The crime as I’ve written about the 2008 financial crisis is not what was illegal about what was legal. There’s this human nature involved. They get rewarded to take big risks with other people’s money. That’s exactly what they’re going to do. I don’t blame them for doing their business, for taking the risks that they take, for using other people’s money to do it, to produce the products they produce. What I think to your point exactly is that if you don’t have a cop on the beat like if there were no speed limits on the highway and no state cops coming after you if you drive too fast, people would drive 120 miles an hour or faster. The roads would be much more dangerous. They drive drunk. Wall Street is no different. Human nature is human nature. There are regulations for a reason. People are required to wear seatbelts. They’re required to drive when they’re not drunk. They’re required to drive and not text. They’re required to drive within the speed limits.

Do some people disregard those laws and get caught for it? Yes. Do some people disregard those laws and not get caught for it? Yes. By and large, most people obey the law and that’s what happens on Wall Street. If you don’t have the laws, if you say, “There is no speed limit. You don’t have to wear a seat belt. You can drive when you’re drunk or drive while you’re texting,” then people would probably do that. There’ll be a lot more accidents and danger. The roads will become weaponized. That’s what is going to happen on Wall Street as we begin to pull back from the 2010 Dodd-Frank Laws and the other rules and regulations that are put in place in the Obama administration. You have to recognize that when you do that, you’re allowing the animal spirits to run free, which allows Donald Trump to make claims about how great the economy is doing, but there are going to be consequences. There always are and there always have been. To think otherwise is historical and people thought that somehow the rules of economics had been lifted in 2006 and 2007. It wasn’t true as we found out in 2008 and we’re going to find that out again.

There are a couple of things going through my mind based on these awesome comments and insights, which is the entrepreneur, they’re quick and they’re agile typically. They’re coming up with an idea here, an idea here and you look at the speed in which technology is allowing society to evolve. You go to the regulation side of things, it’s hard to catch up. I can’t remember which documentary it was. It was giving a snippet of the regulators. Those at the SEC in certain roles that were essentially over a certain element of Wall Street that was taking excessive risk. There’s one person in that role. I’m sure it’s bigger. The government obviously is renowned for not being able to keep up with how fast everything else is going. Do you think that is a characteristic of what’s going on or is that maybe a misinterpretation?

It’s clear that politicians certainly do not understand what goes on Wall Street. Regulators probably do, but they’re definitely outnumbered. On the other hand, there are a lot more regulators floating around these firms than there ever used to be, especially the big firms. Now that they’re regulated by the fed. There are Fed people who go who have offices at these firms. They can go to board meetings. They could look at loan portfolios. They can pretend credit judgment conversations. This is definitely a new world post-2010. Are some of that being rolled back? Yes. There are articles constantly now and fed comments constantly about whether or not there’s too much leverage in the system where the companies are taking on too much debt, which of course they were encouraged to do by the fed because interest rates were kept so low.

AT&T has $180 billion of debt now. It’s the most indebted company on the planet. Is that too much debt? Maybe if the economy stays strong, it’s not. If the economy begins to stumble, there’ll be defaults on that debt and AT&T could go into bankruptcy. It’s not inconceivable. They have $180 billion of debt. That’s a lot of debt and it’s unforgiving. GE has $100 million to $1 billion of debt. Companies are bulked up on debt in part because of interest-expenses taxed deductible so that means appealing from a tax basis and interest rates are very low and are being kept low by the Feds. Trump is job loaning about interest rates and trying to keep the Feds from raising.

The Wall Street guys are always going to be able to outrun the regulators, but the regulators are going to have the last word. They can party for a while and then they have to come with their head in their hands asking for a bailout or to be rescued or saved as happened in 2008. You’d think that Wall Street would be more contrite and want to change what they do and how they reward people. I’ve written 100 pieces about how the compensation system on Wall Street should be changed, but nobody wants to change it so it doesn’t change. That’s what’s going to lead us down into the well again. It’s not going to end. It never does. It won’t this time either. People can’t see that. Nobody rings a bell at the top of the market. Because in the end, we’re taking the punch bowl and going home. Unfortunately, it seems to come out of nowhere and people will be amazed, yet there are breadcrumbs all along. There have been plenty of breadcrumbs.

They’re seeing in hindsight once it all happens.

Financial Crisis: The problem that got us into the financial crisis in 2007 and 2008 is being repeated now, eleven or twelve years later.

The smart people who prepare themselves to be safe as Warren Buffett says, “When the tide goes out, you can see who’s wearing a bathing suit.” We’re at the end of all very long bull market for both stocks and bonds. Companies would be wise and investors would be wise to prepare themselves for a downturn.

I appreciate your insight. This has been awesome. You make comments about the bond market and the common thing we saw the last several years, which is essentially companies taking on debt because of low interest rates, buying back stock. It’s essentially propped up in essence stock prices to an extent. Obviously, the consequences, loading the company with a tremendous amount of debt. With that, do you identify the bond market as one of those potential areas that could be the match for this turmoil or do you maybe see other areas that are out of sync or are unease relative to others? I’ve looked at what caused the crisis in 2008, 2009, where it was the mortgage market. Now looking at where we’re at, are you looking closely in the bond market or other sectors and areas?

If you look at the past financial crisis, it’s when the credit markets seize up, that things get bad. In other words, when people can’t borrow the money they need for a car or a house or to build their business or the money markets. If that all seizes up, if somebody throws sand into the gears of the credit markets, that’s when the financial crises are at their worst. I am very worried about that this time around. Bond prices are very high. Yields are very low and have been for close to ten years now. It’s dangerous to invest in the bond market right now. People can lose an awful lot of money even though it seems like it should be safe.

There are all sorts of excesses going on in the bond market. In the loan market, credit markets where investors are so desperate to get a higher yield because Treasury Securities are yielding so little that go, they’re taking risks without getting the proper rewards, as we talked about before. That is a recipe for disaster. The corporate bond market is now something like $10 trillion of issuance. It was $5 trillion in 2008. You’ve seen a doubling of issuance as a result of interest rates being low for so long. Bonds fluctuate in value as risks are perceived to change. Just look at the bonds of Tesla and GE bonds, it goes on and on.

Can companies turn things around and can discounted bonds be a good investment? Yes, but they can also be a bad investment. They can also go the other way and that happens often and repeatedly. I’m not sure what the catalyst is going to be. There are plenty of things that are going crazy now in the capital markets, in the debt markets. Auto loans defaults are at an all-time high. Corporate debt is at an all-time high. Defaults are relative lows and that means they can only go one direction. I’m worried about it. It could be like a broken clock that strikes twice a day too.

The signs are out there. There are breadcrumbs everywhere. It’s just it hasn’t happened.

Nobody rings the bell at the top of the market. There are two sides to every part of the market. There’s always somebody every day, every minute. When a trade happens, there’s one person who believes that what they bought is going to go up from here. There’s another person that sold it because they believe it’s going down from here. That happens every minute of every day. The aggregate of all of the trading and all of the thinking and all of those bets is the market.

I’m not sure if you’ve read Howard Marks’ new book. I heard him speak and it was interesting where you had this whole emotion that helps human beings work in an emotional side and a rational side. You look at all the rational things that we’ve talked about. This doesn’t make sense. There’s very little rationale as far as why things continue to grow and not correct. It seems like most of that is driven by emotion and wanting more of this and more of that. Obviously, with the gains that the Primary Index has had since the financial crisis, I would say the average investor is continuing to ride the wave and don’t see that there is a crashing of that wave that is on the horizon. I think the greater the emotion builds, it will be interesting to see what happens this go around because the capital markets are a lot bigger than they were in 2007.

You can bank on the fact that it is going to happen, we just don’t know when.

I know that you’re always paying attention to this and your insight was hugely valuable. What are some ways that the audience can follow you or keep up with the analysis that you’re making on? What’s going on in the economy and in markets?

Financial Crisis: Politicians certainly did not understand what goes on on Wall Street.

I have a website, WilliamCohan.com. People can follow along there. I have a new book coming out in July. Put Google Alerts up. Wherever it pops up, it will pop up. I’m a believer in organic, not feeding people what I write. If they come by it organically, that’s great. If they don’t, it’s okay. So be it.

About William D. Cohan

William D. Cohan, a former senior Wall Street M&A investment banker for 17 years at Lazard Frères & Co., Merrill Lynch and JPMorganChase, is the New York Times bestselling author of three non-fiction narratives about Wall Street: Money and Power: How Goldman Sachs Came to Rule the World; House of Cards: A Tale of Hubris and Wretched Excess on Wall Street; and, The Last Tycoons: The Secret History of Lazard Frères & Co., the winner of the 2007 FT/Goldman Sachs Business Book of the Year Award. His book, The Price of Silence, about the Duke lacrosse scandal, was published in April 2014 and was also a New York Times bestseller. His new book, Why Wall Street Matters, was published by Random House in February 2017. He is a special correspondent at Vanity Fair and a columnist for the DealBook section of the New York Times. He also writes for The Financial Times, The New York Times, Bloomberg BusinessWeek, The Atlantic, The Nation, Fortune, and Politico. He previously wrote a bi-weekly opinion column for The New York Times and an opinion column for BloombergView. He also appears regularly on CNN, on Bloomberg TV, where he is a contributing editor, on MSNBC and the BBC-TV. He has also appeared three times as a guest on the Daily Show, with Jon Stewart, The NewsHour, The Charlie Rose Show, The Tavis Smiley Show, and CBS This Morning as well as on numerous NPR, BBC and Bloomberg radio programs.

He is a graduate of Phillips Academy, Duke University, Columbia University School of Journalism and the Columbia University Graduate School of Business. He grew up in Worcester, Massachusetts and now lives in New York City with his wife and two sons.

About the host

Patrick Donohoe

CEO Paradigm Life

Patrick is the President and CEO and started Paradigm Life in 2007 after learning from his mentor Kim Butler about financial strategies outside of Wall Street.

With a background in economics and marketing, Patrick immediately realized the opportunity to teach investors, business owners, professionals and families on a large scale using modern digital media and communication technology. Since 2007 Paradigm Life has worked with thousands of individuals in all 50 states.

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